Carbon pain will be felt in the long term

Labor has, in effect, handed responsibility for reducing Australian emissions to the 30 countries of the European Union and created a budgetary problem in 2015 if the scheme is still in place.

In the medium term, the changes could mean it will be cheaper for Australian companies to discharge their carbon liabilities after 2015 but in the long term it will be more expensive.

The immediate reaction from the energy sector yesterday indicates the announcement is a positive for Labor in looking to soften the edges of its scheme. But looking further ahead the changes mean prices will be higher.

The key to understanding the changes is that an unworkable floor price –which Labor never liked – from 2015 has been scrapped. Instead, it is seeking to limit price downside by reducing access to the international carbon market through the United Nations Clean Development Mechanism. Prices in the CDM are trading at about $4 and show little sign of recovering.

By limiting access to this market, the government is reducing access to the least-cost abatement opportunities that exist in developing countries, in which CDM projects are based. This means that after 2018 – when the price floor was meant to be removed – Australian companies will have to pay more for carbon and there will be a greater incentive to invest in low-carbon technology.

What happens in Australia to the price of carbon will now in effect be determined by the European economy and whether EU members decide to take measures to bolster its sagging emissions trading scheme. It is more likely the price in Europe is on the upside.

However, if Australian companies start snapping up cheap European permits at $10 it creates a headache for the Opposition, if it is elected and seeks to roll back the scheme.

With a price floor, it was unlikely industry was going to buy future permits. But with that removed, there is an immediate buying opportunity.

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Even if the carbon price scheme is rolled back, they can sell European permits back into that market, possibly at a profit. It also means companies buying now will have a vested financial interest in the Australian scheme continuing.

For emissions-intensive, trade- exposed industries, it also creates an arbitrage opportunity to buy cheap international permits –even though the amount has been curtailed – and sell the permits they have been given by government. The changes also mean that parts of the original Treasury modelling aren’t worth the paper they are written on. Yet yesterday Climate Change Minister
Greg Combet
was standing by that modelling.

That modelling and promised tax cuts are premised on a $29 carbon price in 2015 and also full international linkage. Even if the price of European carbon is bolstered by EU policy changes, analysts are still looking at a 2015 price of $18-$20.

Projecting future carbon prices is an inherently fraught exercise, so the optimistic Treasury projections may yet come to pass. But on current indications, government carbon revenue will be cut by one third to one half, depending on what happens in Europe. However, 2015 is some time off and on present polling it is unlikely to be Labor’s problem.